Green Shoots for the Global Economy

What happens in China clearly does not stay in China so the outlook for China’s growth in 2019 is one of the keys to how the global economy will perform and how financial markets will respond to that level of growth. As discussed last month after the 19 Party Congress meeting in October 2017, China clamped down on the shadow banking system with a series of regulatory changes after a period of unchecked growth. The growth of the shadow banking system had soared from $1.5 trillion at the end of 2012 to more than $9 trillion at the end of 2016, fueled by Asset Management Products, Entrusted Loans, and Peer-to-Peer lending. In the short run the contraction in the shadow banking system caused the rate of change in Total Credit growth to slow. The reduction of credit growth through the shadow banking system during 2018 contributed to a slowdown in corporate loan growth, offset the growth in bank lending, and an economic slowdown especially in Q4. The success in curbing the shadow banking system provided policy makers the flexibility to loosen monetary policy through traditional measures. The Peoples Bank of China (PBOC) has significantly lowered the Required Reserve Ratio for large and small banks by 2.0% since October after announcing the fifth reduction in the past year. The reductions in the past year from 17.5% to 13.5% represent a drop of 22.8% almost twice as large as the easing in 2014 and 2015. In response to the PBOC’s easing, the yield on China’s 10-year bond has fallen from 3.70% in late September to 3.18% at the end of February.

The expectation has been that the Chinese economy should begin to show the effects of the PBOC’s aggressive easing, if my expectation of a firming in the Chinese economy was to take hold by mid-year. Since it normally takes from 6 to 12 months for monetary policy changes to gain traction, filter through an economy, and begin to materialize in economic reports, it is important that confirmation of this outlook materialize. One initial sign would be that the additional liquidity freed up by the reductions in the Required Reserve Ratio is flowing out of the banking system and into the economy through increasing credit growth. Bank lending increased significantly in January which boosted the 12 month rate of change. The increased level of regulation after the 19 Party Congress meeting in October 2017 of the shadow banking system is clearly evident (grey shaded bars) and into the end of 2018. It appears that regulators eased up in late 2018 as the 12 month rate of change in the shadow banking system was far less negative. The January improvement in Total Social Financing is the largest increase since the PBOC’s response after the 2008 financial crisis. The easing of monetary policy and increased flow of credit has led to an upward reversal in fixed asset investment and, if continued, would help stabilize China’s economy in the short run and lead to a firming as 2019 unfolds.